Tuesday, 20 August 2013

A rebound in UK house prices is not all good news

The government in
Britain has done its damnedest to revive the property market but this does not
bode well for the future

Buying a house is typically the largest and most important
purchase any of us will make. It is a
pity then that the property market is subject to the whims of policy while also
being caught up in a craze in Britain for investing in real estate. These forces have collimated to fuel a
resurgent property market with new schemes from the government in Britain along
with pledges for low interest rates while investment in property is growing
again due to a dearth of other options. But,
rather than being celebrated, it should be seen as a distortion coming at the
same time as the economy is in its worst slump for decades. How did this strange turn of events come to
be and why should we worry about it?

The property market, like any other market, should be
controlled by the forces of demand and supply.
People need houses to live in, somewhere close to where they work, which
is the source of demand for real estate in any specific location. The supply is the current amount of buildings already
standing as well as any new houses that have just been put up. The number of jobs, and attractiveness of the
location, will dictate the strength of demand which is why house prices in
London are higher than elsewhere.

Property prices will also affect demand – higher prices will
put people off moving to popular places while cheap housing will lure people to
previously shunned areas. Supply too is
influenced by price with more houses likely to be built in locations where
prices are high because more people want to live there. The effects of both adding more buildings and
of people moving away to find cheaper housing work in a way to temper the
rising cost of property in desirable places.

However, houses are not the same as other commodities that
we buy and sell. There are numerous forces at work which push property prices
up higher than would normally be the case; residential property is a source of investment for many people who buy-to-rent
and this adds to the demand for property in prized locations, the government in the UK likes to promote home
ownership due to the belief that it gives people a greater stake in their
community, and monetary policy targets
the housing market with low interest rates used to spur on purchases of real
estate as this is deemed to be good for the economy.

The boom and bust that came with the global financial crisis
provides a great case in point. Interest
rates were relatively low in the early 2000s with the base rate set by the
central bank reaching a low of 3.50% in 2003 and only edging up to 5.75% by 2007. Cheaper mortgages fuelled a surge in prices and
this was exacerbated by the media playing up the money to be made through
investing in property. The Bank of
England was not concerned about this rampant rise as theory had taught economists
to focus on inflation (for more, see Time to rethink Inflation). And the
government was also spurring on the economy with its own borrowing and spending
binge.

This all ended in spectacular fashion with a massive slump
in property prices as lending dried up with the onset of the global financial
crisis. The government has since stepped
in to try and prop up the housing market with its Help to Buy scheme which
offers up financing support for home buyers to make up for limited lending options. The government’s efforts to bolster the
property market have instead triggered concerns about the perkiness of the real
estate market at a time when the economy is not doing so well.

Data released in the middle of August shows that property
prices in the UK are rising as fast as during the boom in 2007 (but prices have
yet to reach the same peaks as in 2007) with lending to first-time buyers also
reaching a six-year high. Yet, although
the government has succeeded in reflating the property market, its aim of
promoting home ownership is in tatters as this has dropped to 65.3% of
households – which is the lowest level in 25 years.

Low interest rates add extra impetus to the recovery in the
real estate market through two routes – making mortgages cheaper, but also
making property a more attractive investment compared to leaving money in the
bank. As such, lending to landlords has
also surged of late and reached the highest levels since late 2008. This all suggests that the pickup in prices
does not reflect an increase in genuine demand for houses but interest in
property has been artificially generated as a part of government and central
bank policy.

This premature rebound in house prices is a boon for some
but puts many others at a severe disadvantage.
While house owners will be sighing in relief, any prospective buyers
will have to pay prices for property which have been inflated by the
government. In essence, the government
is supporting the haves while penalising the have-nots with the goal of trying
to shore up the economy. Many of the
have-nots are young people who are also struggling to find work amid the worst
job market for decades.

So along with lower pay, there will be a generation shackled
with higher debt (if they are one of the lucky few who are able to grab onto
the lower rungs of the property ladder) which does not bode well for consumer
spending in coming years. A buoyant
property market now also means a slow rate of rises in house prices in the
future – higher prices for property rely on increases in wages which were
sluggish even before the global financial crisis. So the government is cashing in on higher
house prices now at the cost of a weaker property market in the future. It seems like the government is going to a lot
of trouble for something that is more likely to cause problems somewhere down
the line. Isn’t that how we got stuck in
this slump in the first place?